Rich Dad Education – Real Estate Blog

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Using Net Operating Income (NOI) to Make Smart Investment Decisions

Rich Dad Education Real Estate

As investors, our worst nightmare is to over pay for a piece of real estate. If you have attended my training, you may recall I have stressed several times that after a real estate closing, no one cares about you including the broker. This is why I have stressed on the importance of understanding value and the proper use of Net Operating Income (NOI) when valuing real estate.

When calculated correctly, NOI is essential to establishing purchase price, financing and a future sale price for any investment property. This can be established by calculating the acquisition cap rate and disposition cap rate and understanding debt service coverage ratio. This will be discussed more thoroughly in future blogs. Now take a moment and ask yourself, “Do investment properties appreciate in the same manner that single family properties do?”  The answer is NO. Single family and two family homes will appreciate through the effects of supply and demand as well as the absorption of the market during that specific period of time.

Here is an example that will help you better understand the effect that NOI has on appreciation.  Tom purchased a strip mall four years ago with the NOI at $50,000. Today, the NOI has stayed constant at $50,000. Did the appreciation of the building increase, decrease or stay the same throughout the years?

The correct answer is it would stay the same. Let’s recall, if your income levels do not increase on the building, which can be accomplished by raising the price of rent and keeping the expenses in control, the building will not appreciate. That’s why we project future value, so we can hit our benchmarks every year. Keep in mind, you are not only buying the building; you are also buying the income stream that the building generates.

When you are in the market for an investment property, the seller or listing broker will provide you with a pro-forma. A pro-forma is a detailed description of all income and expenses on that specific property. So let’s be smart. Before using those numbers to calculate a final purchase price, ask yourself, “Where did those numbers come from?”

Keep in mind; they come from the person who is trying to sell you their building. That’s why NOIs are sometimes called “liars’ statements.” Before accepting the NOI, we must thoroughly examine the pro-forma using sound due diligence. That will give us a better indication of what is really behind the numbers. In other words, this process can be described as reconstructing the pro-forma. This is our way to understand how we are going to own and manage our investments. Keep in mind; typically, no two investors will own and manage the building the same way.

NOI is the remaining income after all expenses have been paid excluding the debt service. I have provided a simple formula below that will help you better understand the calculations:

Potential Rental Income 

Vacancy and Credit Losses

= Effective Retail Income

+ Other Income

=Gross Operating Income

Operating Expenses

= Net Operating Income (NOI)

Once you have fully understood and acknowledged the importance of NOI, valuing real estate becomes that much easier. In doing so, you will be able to make smarter decisions while cutting the time spent on deals that aren’t favorable.

Throughout our income property training,  we explore and provide many ways to value real estate  through the use of NOI. Stay tuned for more helpful tips.

By Jim Aviza

Rich Dad® Education Elite Training Mentor

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3 responses to “Using Net Operating Income (NOI) to Make Smart Investment Decisions

  1. Willian Trincher / Linda Moore June 17, 2014 at 7:37 pm

    We completed the 3 day course in April and have started to work with a fellow Rich Dad Poor Dad investor. After providing over 20 viable properties, that investor hasn’t taken any action to proceed. Having no funds to initiate contracts ourselves, we would appreciate any ideas on what our next step should be. We are highly motivated and coachable.

    • David Gelkin June 25, 2014 at 7:00 pm

      In the recent RichDad Live training event, “Investing with other peoples money”. The concept of infinite returns was explained. During the discussion Mr Kyosaki, made the comment,

      “you don’t need money to invest. Any idiot can invest with money, it take brains to invest with none.”

      The golden key is to find motivated sellers. Then the discussion can open up about how to make a deal work.

      In the Live training event, the example provided was a large acre plot of land in Arizona with a run down dinner/home on the property. Which had been on the market for a long time with no interested buyers.

      Mr Kyosaki and his team, offered to buy the plot at asking price with the deal inclusion that the price would be paid in full in one years time, with nothing down immediately. The seller agreed to the deal.

      Then the example continued to show. How a small additional renovation investment brought the property up to a level which could be sold on for a profit. The land plot acreage was sub-divided so the property and a small parcel of land sold for enough to cover the 1 year repayment commitments from the initial deal.

      To this day Mr Kyosaki said he still owns the acreage plot of land which he paid nothing for.

      The key to this was the motivated seller, that accepted the 1 year delayed repayment proposal.

      I am not a richdad coach. However I am a student of the richdad education materials and books. Feel free to connect with me on LinkedIn.

  2. David Gelkin June 25, 2014 at 7:03 pm

    n the recent RichDad Live training event, “Investing with other peoples money”. The concept of infinite returns was explained. During the discussion Mr Kyosaki, made the comment,

    “you don’t need money to invest. Any idiot can invest with money, it take brains to invest with none.”

    The golden key is to find motivated sellers. Then the discussion can open up about how to make a deal work.

    In the Live training event, the example provided was a large acre plot of land in Arizona with a run down dinner/home on the property. Which had been on the market for a long time with no interested buyers.

    Mr Kyosaki and his team, offered to buy the plot at asking price with the deal inclusion that the price would be paid in full in one years time, with nothing down immediately. The seller agreed to the deal.

    Then the example continued to show. How a small additional renovation investment brought the property up to a level which could be sold on for a profit. The land plot acreage was sub-divided so the property and a small parcel of land sold for enough to cover the 1 year repayment commitments from the initial deal.

    To this day Mr Kyosaki said he still owns the acreage plot of land which he paid nothing for.

    The key to this was the motivated seller, that accepted the 1 year delayed repayment proposal.

    I am not a richdad coach. However I am a student of the richdad education materials and books. Feel free to connect with me on LinkedIn.

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